Chapter 12: Efficiency of Commodity Money Equilibrium
1 In an Arrow2Debreu model all competitive equilibrium allocations are Pareto efficient; that is the first fundamental theorem of economics. That result does not fully generalize to the trading post model with transaction costs. The efficiency concept must be suitably refined to reflect the technically necessary transaction costs associated with reallocating ownership from producers and suppliers to consumers. Those transaction costs are technically necessary and do not interfere with efficient resource allocation. When the multiplicity of budget constraints results in a reallocation of resources or incurring additional transaction costs to fulfill them, the resulting reallocation is a resource cost needed to fulfill the administrative constraint of budget balance rather than technical necessity. Those costs are wasted and the resulting allocation cannot be Pareto efficient. Conversely when there is a transaction-costless medium of exchange, the resulting trading post equilibrium allocation is Pareto efficient. 1 TRANSACTION COSTS, ESSENTIAL AND INESSENTIAL SEQUENCE ECONOMIES The issues of general equilibrium with transaction cost, efficiency of allocation and the implications for the role of money appear in Foley (1970), Hahn (1971, 1973), and Starrett (1973). Foley considers a static equilibrium with (consistent with the Arrow2Debreu treatment) a single market meeting. All of the formal structure of the Arrow2Debreu economy is maintained while the transaction process is treated as a production activity. Each of N goods has a bid and ask (wholesale and retail) price with the resulting dimensionality of the price space at 2N. As in Debreu (1959) the count N includes futures markets for all...
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